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Bye-bye, long bond; we won't miss you much

How about that long bond?

For decades, that's been a flip conversation starter among finance nerds, such as the sports-talk opener, "How 'bout those Phillies?"

But not anymore. The Treasury Department is discontinuing new sales of its 30-year bond, the longest-maturity bond it has sold.

Since its introduction in 1977, the long bond's fluctuating price and yield have been a key gauge of financial market performance. In times of trouble, money managers around the world would "flee to quality," selling stocks and buying the 30-year bond, whose interest and principal payments were guaranteed by the government. Indeed, as a haven, the long bond all but replaced gold.

Aside from offering security, the long bond usually provided the highest interest rate, or yield, of any government bond.

So you would think its slide into oblivion would be a sad day for investors, pensioners _ for anyone with a stake in the financial markets.

In fact, many of us will benefit from the retirement of the long bond. Sure, investors won't be able to lock in yields for 30 years, but for most of us that would be a a mistake anyway.

Government bonds, of course, represent government borrowing. If you pay $1,000 for a bond, you are lending that sum to the government for a specified period. At the end of that time, the bond matures and you get your $1,000 back. In the meantime, the government pays you interest. To get your money back early, you can sell the bond to someone else.

With the government running budget surpluses recently, it can save money by borrowing with bonds that mature in 10 years or less. That's because bonds with shorter maturities generally pay lower yields, because investors don't demand as much if their money won't be tied up as long. A three-month Treasury bill, for instance, currently yields a stingy 2 percent, compared with nearly 5 percent on the 30-year bond.

With no new 30-year bonds being issued, the supply will gradually shrink as existing bonds mature and cease to exist. Big investors are thus likely to buy more 10-year notes, and the increased demand will drive that bond's price up.

A bond's interest payment is a dollar amount fixed for the life of the bond. That payment, therefore, represents a lower interest rate if the bond price rises in subsequent trading. A $50-a-year payment is 5 percent when the bond is priced at $1,000, but it is only 4.55 percent if the price rises to $1,100.

Even if you're not a bond investor, this may be important to you. When yields on the 10-year note fall, rates on mortgages and other loans tend to fall as well. Mortgage debts, for instance, are bundled into securities that compete with bonds for investors' dollars, with certain adjustments for risk.

If mortgage rates rise to levels significantly higher than those of 10-year notes, bond investors will move their money to mortgage-backed securities. With demand higher, prices will go up on those securities and yields will go down, while prices for the less-desirable 10-year notes will fall and yields will rise. The two securities will thus quickly move back into equilibrium, paying about the same yield.

Bottom line: Though mortgage rates are near record lows of about 6.5 percent, they may well go lower as bond investors turn to the 10-year note to replace the 30-year bond.

What about investors who buy 30-year bonds, which will still be bought and sold on the secondary market? Are they getting a bad deal now that there will be fewer of them?

Sure, some are unhappy about it, but the 30-year bond appealed primarily to money managers and rich people, not ordinary folk. Big bond investors are often betting on price gains that will come if prevailing interest rates fall.

That's not a game for small investors, because there's always a risk that prevailing rates will rise, causing bond prices to plummet. Small investors avoid that risk by holding bonds until they mature and the guaranteed principal repayment is made. For most people, 30 years is too long to tie money up; the 10-year note makes much more sense.

Indeed, the 10-year note recently yielded 4.3 percent, not much less than the 4.89 percent of the 30-year bond. Moreover, prices on the 10-year note are less volatile, because investors don't risk being trapped as long if prevailing yields rise. In fact, many financial advisers say that when risk and yield are both taken into account, the small investor does best with bonds maturing in two to six years.

No need, then, to mourn the passing of the long bond.

_ Jeff Brown writes for the Philadelphia Inquirer.